Cost Segregation: A Potential Permanent Tax Savings

With the recent administration change in Washington, D.C., tax reform is a growing topic of conversation. The effort required to accomplish tax reform is no simple task and could encompass a variety of new provisions, the effects of which are currently unknown. However, the most discussed change involves the lowering of business and individual tax rates.

Increasing the Value of DeductionsWith the chance of a reduction in tax rates, tax deductions become even more valuable in tax years before the rates are lowered. Accelerating deductions into the 2016 tax year would lower tax liabilities when rates are high and shift income into future years when rates are anticipated to be lower, thereby, permanently reducing tax liabilities.

Timing a Cost Segregation StudyIf you own real estate, cost segregation could be a very beneficial tax planning tool. IRS rules allow taxpayers to apply a cost segregation study any time after the building is purchased, renovated, or constructed, which provides a unique opportunity to plan which tax year depreciation deductions are realized. Taxpayers who have opted not to perform a cost segregation study in the past should now reconsider, as the tax savings could be made permanent by the potential rate changes.

ExampleABC, Inc. owns a building that was purchased in 2014 for $1 million. ABC has a cost segregation study performed on their building and applies it to their 2016 tax return. The cost segregation study accelerates $100,000 of future depreciation deductions into the 2016 tax year where the top federal income tax rate is 39 percent, creating an immediate tax savings of $39,000. Assuming tax rates drop in 2017 and subsequent years to a top rate of 30 percent, the deductions that would have been taken by ABC had the cost segregation study not been done would have saved $30,000 in tax. By completing the cost segregation study and applying it to 2016, ABC realizes a $9,000 permanent tax savings. This is on top of the traditional benefits of accelerated cash flow generated by the $39,000 cost segregation study 2016 tax savings.